Capital Intensive

What it is:

Capital intensive refers to the degree that a company must invest money in physical or financial assets in order to produce a profit.

How it works (Example):

Airlines, auto manufacturers, and drilling operations are often considered capital-intensive businesses because they require large amounts of expensive equipment and raw materials to make their products. Businesses like web site design, insurance, or tax preparation generally depend on labor rather than physical assets and are thus not considered capital intensive.

Although there is no mathematical threshold that definitively determines whether an industry is capital intensive, most analysts look to a company’s capital expenses in relation to its labor expense. The higher the ratio between capital and labor expenses, the more capital intensive a business is. For example, if Company XYZ spent $10,000,000 on equipment in one year but only $3,000,000 on labor, Company XYZ is probably in a capital-intensive industry.

Why it Matters:

Capital-intensive businesses need a lot of money to keep operations going. Thus, capital intensity serves as a barrier to entry, and existing capital-intensive businesses benefit from this. Having this barrier to entry means it is difficult for new companies to begin operating in capital-intensive industries. For instance, it is highly unlikely a new aircraft firm would begin operations and compete with the likes of Boeing, since it costs billions in capital to begin producing airplanes.

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